Running Toward Trouble

Articles

Dwayne Hines II

Running Toward Trouble
Apr 19, 2003

For the past couple of days the Wall Street Journal has carried front page stories on the current issue of major discussion on the New York Stock – front-running. What is front- running? Front-running is the name given to the practice of stepping in front of another person’s trade and making a slightly more favorable exchange. What makes this a particular problem is that the front-runners, those who are trading in front of others, are the specialists who are suppose to be making a trade for clients. The front-running practice occurs when a specialist trades ahead of a customer for the specific benefit of the specialist. Front-running is the ultimate “conflict of interest” play and the practice is under investigation by the Big Board and the Security and Exchange Commission. One of the more prominent specialists, David Finnerty, was suspended this week in connection to front-running activities. The Wall Street Journal has noted that the issue puts a precious asset at risk – trust. Trust has been a big issue at the New York Stock Exchange as the industry tries to repair the collateral damage due to the accounting scandals. The front- running issue has become central enough that NYSE chairman and CEO Richard Grasso has stepped into the fray. His exchange is not the only one that should take a deep look at the problem of front-running. The NASDAQ should also investigate the front-running issue, and the SEC needs to expand its examination from the Big Board to the NASDAQ and the Over-The-Counter Bulletin Board (OTC BB) as well. The OTC Bulletin Board is of particular concern in the area of front-running as it is supposedly not as closely watched or regulated as the other two major exchanges. To provide a real service to the investment community, the SEC should take a strong review of front-running activity at the OTC BB. The Wall Street Journal has noted that with online trading, investors are more adept at watching the action and some of the OTC BB action is definitely worth poking into by the SEC. Some of the stocks are thinly traded at times and this makes the market maker’s moves all the more evident. While the New York Stock Exchange utilizes the “open outcry” system from the trading floor, the OTC BB is executed electronically at various regional centers. Use of the Internet allows the investor to watch just who is making the moves and it can be quite frustrating to have a trade in place and see a specialist or market maker step in front of a trading position and take their own piece of the pie first. It would not be a total surprise if a thorough investigation turned up rampant front- running at the OTC BB, and perhaps even at the NASDAQ. The front-page exposure in the Wall Street Journal has turned heads at the Big Board and is also probably raising a few eyebrows at the NASDAQ and OTC BB. As long as the SEC is going to get involved, it would be a good time to roll up their sleeves and go beyond the Big Board, by turning over the rocks at the other exchanges as well. The SEC is the regulating body for all of the exchanges and given the mandate of insuring fair play and it needs to do so. Front-running is definitely not fair play and if the SEC finds such activity, it needs to take action at each level. The SEC should review the trading action for a broad group of stocks in each of the exchanges for a period from prior to 2000 (say starting at 1999, for example) to current in order to get a realistic picture of what has been going on. The data examined from the trades needs to be historical as the specialists can read the papers and curb the front-running practice to avoid the heat for a period. However, a historical perspective cannot be altered and will give the SEC a good overview of the situation. Each of the exchanges (NASDAQ, OTC BB, etc.) also have a regulating arm and these bodies should step in strongly to address the issue. Immediate action is called for at every level, up to and including the OTC BB system. If the SEC and the various trading exchanges wish to build and foster investor trust, an element of paramount concern in this investment climate, issues such as front-running should not be allowed to exist.

About the author: Dwayne Hines currently has 12 books selling in major bookstores and writes for major magazines such as Physical and FitnessRX. Email Dwayne Hines: dhines@3dinet.com

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